The crowding-out effect implies that:
A)increases in government purchases will lower interest rates and stimulate investment spending.
B)higher taxes reduce both consumption and saving.
C)fiscal policy effects on interest rates will be offset by monetary policy.
D)increases in government purchases increase income and the demand for loanable funds which will choke off some private spending.

Question

The crowding-out effect implies that:
A)​increases in government purchases will lower interest rates and stimulate investment spending.
B)​higher taxes reduce both consumption and saving.
C)​fiscal policy effects on interest rates will be offset by monetary policy.
D)​increases in government purchases increase income and the demand for loanable funds which will choke off some private spending.

Quizplus · Accepted Answer

The crowding-out effect is caused by an increase in government purchases that leads to an increase in the demand for loanable funds, which causes interest rates to rise. Higher interest rates reduce private investment spending, which offsets the initial increase in government purchases. This decrease in private investment is known as the crowding-out effect. Therefore, option D is the correct answer as it describes the effect of an increase in government purchases on private spending through the increase in the demand for loanable funds.

The Crowding-Out Effect Implies That